Economic Unit 2 Review

Chapter 4.1 – What is demand?

• Demand – combination of desire, ability and willingness to buy a product
• Microeconomics – part of economics that studies small units, such as individuals and firms

An introduction to Demand

• Market economy – economic system in which people and firms make all economic decisions
• Demand schedule – a table that lists how much of a product consumers will buy at all possible prices
• Demand has two variables: price and quantity
• Demand curve – a curve that shows the quantities demanded at all possible prices

The law of demand

• Law of demand – rule stating that consumers will buy more of a product at lower prices and less at higher prices (inverse relationship)
• Market demand curve – a curve that shows how much of a product all consumers will buy at all possible prices

Demand and marginal utility

• Marginal utility – additional satisfaction or usefulness a consumer gets from having one more unit of a product
• Utility – the pleasure, satisfaction, or benefit a person receives from consuming a product
• Diminishing marginal utility – decrease in satisfaction or usefulness from having one more unit of the same product

Chapter 4.2 – factors affecting demand

Change in the quantity

• Change in quantity demanded – movement along the demand curve showing that the amount someone is willing to purchase changes when the price changes
• Income effect – that part of a change in quantity demanded due to a change in the buyer’s real income when a price changes
• Substitution effect – that part of a change in quantity demanded due to a price change that makes other products more or less costly

Change in demand

• Change in demand – shift of the demand curve when people buy different amounts at every price
• Changes in consumer income can cause a change in demand
  • Normal goods – direct relationship
  • Inferior goods – inverse relationship
• Change in consumer tastes and preferences can cause a change in demand (direct)
• Substitutes – competing products that can be used in place of one another (direct)
• Complements – products that increase the use of other products (inverse)
• The way people think about the future can affect demand
• The market demand curve can also change if there is a change in the number of consumers (direct relationship)

Chapter 4.3 –  elasticity of demand

• Elasticity – a measure of responsiveness that shows how one variable responds to a change in another variable

Demand elasticity

• Demand elasticity – a measure that shows how a change in quantity demanded responds to a change in price, determined by time, substitutes, income
• Elastic – type of elasticity where a change in price causes a relatively larger change in quantity demanded
• Inelastic – type of elasticity where a change in price causes a relatively smaller change in quantity demanded
• Unit elastic – type of elasticity where a change in price causes a proportional change in quantity demanded

The total expenditures test

• Total expenditures = price (quantity demanded)
• If a business can determine a new product’s demand elasticity, it can find the price that will maximize total revenues

Determinants of demand elasticity (if yes: elastic, if no: inelastic)

• Can purchase be delayed?
• Are adequate substitutes available?
• Does purchase use a large portion of income?

Chapter 5.1 – what is supply?

• Supply – amount of a product offered for sale at all possible prices
• Law of supply – principle that more will be offered for sale at higher prices than at lower prices

An introduction to supply

• Supply schedule – a table showing how much a producer will supply at all possible prices
• Supply curve – a graph that shows the different amounts of a product supplied over a range of possible prices
• Market supply – a graph that shows the various amounts offered by all firms over a range of possible prices
• Quantity supplied – amount offered for sale at a given price
• Change in quantity supplied – change in amount offered for sale when the price changes

Change in supply

• Change in supply – situation where different amounts are offered for sale at all possible prices in the market; shift of the supply curve (direct relationship)
• A change in the cost of productive inputs such as land, labor, and capital can cause a change in supply
• Increase productivity, more output is produced at every price, which shifts the supply curve to the right
• New technology tends to shift the supply curve to the right.
• Taxes increase causes the supply curve to shift to the left
• Expectations about the future price of the product can also affect supply
• When the government establishes new regulations, the cost of production can change, causing a change in supply
• A change in the number of suppliers can cause the market supply curve to shift to the right or left

Elasticity of supply

• Supply elasticity – a measure of how the quantity supplied responds to a change in price
  • Are resource inputs readily available?
  • Are factors mobile – are workers prepared to move to where they are needed?
  • Can finished products be easily stored, and are they existing stocks?
  • How long and complex is the production cycle or production process?
  • Time is the sole significant determinant of price elasticity of supply
• The three elasticities

Chapter 6.1 – prices as signals

• Price – monetary value of a product as established by supply and demand
• High prices signal buyers to buy less and producers to produce more, vice versa

Advantages of Prices

• Prices are neutral, they favor neither the producer nor the consumer
• Flexible
• Most people have known about prices all their lives
• Prices have no cost of administration

Prices as a system

• Not only help individuals make decisions; they also serve as signals that help allocate resources between markets
• Rebate – partial refund of a product’s original price
• Alternative to the price system – rationing – used in command like economy (problems below)
  • Equity/fairness
  • Administrative cost
  • No incentives
  • Inefficient/opaque

The price adjustment process

• Market economy are voluntary, compromise settles differences between buyers and sellers
• Economic model – a simplified version of a complex behavior expressed in the form of an equation, graph, or illustration
• Equilibrium price – price where quantity supplied equals quantity demanded
• Surplus – situation where quantity supplied is greater than quantity demanded at a given price
• Shortage – situation where quantity supplied is less than quantity demanded at a given price

Explaining and predicting prices

• Change in supply and or demand may occur based on situations
• These changes affect price
• Whenever supply or demand for a product fluctuates, the elasticity of the two curves affects the size of the price change

When markets talk

• Markets send signals in that they speak collectively for all the buyers and sellers who trade in the market
• Talk when prices move up or down significantly in reaction to events that take place elsewhere in the economy